Monetarism is a macroeconomic theory which posits that governments can promote economic stability by targeting the growth rate of the money supply. Essentially, it posits that the total amount of money in an economy is the primary determinant of economic growth.
Key Insights:
- Monetarism is a macroeconomic theory suggesting that governments can stabilize the economy by targeting money supply growth rates.
- Central to monetarism is the quantity theory of money, which states that money supply (M) multiplied by the rate of spending (V) equals nominal expenditures (P \* Q) in the economy.
- Monetarism is closely associated with economist Milton Friedman, advocating for a steady expansion of the money supply in alignment with natural economic growth.
- It emphasizes monetary policy over fiscal policy to manage aggregate demand, contrasting with most Keynesians.
- Some core tenets of monetarism remain influential despite modern economists’ rejection of strict money growth emphasis.
Advancing Economic Understanding: Origins and Application of Monetarism
Monetarism is centered around the idea that the supply of money within an economy is the core driver of economic growth. With increased money availability, the aggregate demand for goods and services rises. This boost in demand encourages job creation, reducing unemployment rates and invigorating economic growth.
Monetary policy, a pivotal tool in monetarism, involves adjusting interest rates to regulate the money supply. Higher interest rates incentivize savings, contracting the money supply, while lower rates encourage borrowing and spending, thereby stimulating economic activity.
Milton Friedman: A Pioneer in Monetarism
Monetarism is inextricably linked to Nobel laureate Milton Friedman. He posited that monetary policy should maintain a steady, predictable expansion of the money supply, slightly increasing annually to match natural economic growth rates. In A Monetary History of the United States, 1867–1960 co-authored with Anna Schwartz, he cited the significant role of monetary policy in economic stability.
Notably, Friedman suggested a fixed growth rate for the money supply, known as the K-percent rule, promoting stable economic growth and low inflation by linking money supply growth to nominal GDP.
Central Theory: The Quantity Theory of Money
Central to monetarism is the quantity theory of money. Initially formulated by John Stuart Mill and later becoming a keystone in Keynesian economics, this theory equates money supply (M) and its velocity (V) with nominal expenditures (P \* Q). The equation highlights the significance of money supply fluctuations in determining inflation, production, and employment.
1MV = PQ
2
3Where:
4M = money supply
5V = velocity (rate money changes hands)
6P = average price level
7Q = quantity of goods/services
Changes in money supply (M) prominently drive the equation, directly impacting employment, inflation (P), and production (Q). A varying money supply invariably influences prices and economic output.
Monetarism vs. Keynesian Economics
Monetarism diverges from Keynesian economics in its views on money supply. While Keynesians see velocity as volatile and central to economic shifts, monetarists believe it is predictable, emphasizing controlled money supply growth over fiscal interventions.
The Monetarist Legacy: Historical Impact and Evolution
Gaining prominence in the 1970s, monetarism steered policies to combat inflation in the U.S. and U.K. Although its theoretical prominence waned, the fundamentals it introduced influenced future economic policies and monetary targeting perspectives.
In real-world scenarios such as the actions of former Fed Chairman Ben Bernanke and U.K. Prime Minister Margaret Thatcher, monetarist principles significantly impacted economic recovery and stability.
Real-World Examples
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Paul Volcker and Inflation Control: In 1979, Federal Reserve Chairman Paul Volcker employed monetarist strategies to curb inflation by tightening money supply, which led to decreased inflation albeit at the cost of a severe recession.
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Thatcher’s Financial Policies: In the U.K., Prime Minister Margaret Thatcher adopted monetarist policies to reduce soaring inflation, successfully halving it by 1983.
Despite facing challenges and a decline in widespread acceptance, the principles of monetarism continue to offer valuable insights and strategies in contemporary economic discussions.
Related Terms: Keynesian Economics, Interest rates, Inflation, Unemployment rate, Fiscal policy, Real GDP.
References
- International Monetary Fund. “What Is Monetarism?”
- Federal Reserve Bank of St. Louis. “Effective Federal Funds Rate”.
- International Monetary Fund. “What Is Monetarism?”
